A method of picking stocks that is closely related to technical analysis is momentum investing.
Anyone who's ever watched a snowball going down a hill knows how quickly it picks up speed.
That's momentum in action!
Momentum investors look for stocks that are moving at high speeds, on the theory that you can just ride out a stock as long as it continues to rise in price -- as long as you bail out before the stock crashes and burns!
It's not unusual to hear:
"The index reached a new high today with this or that sector leading the way."
The recent incredible bull market has brought momentum investing into the spotlight and some investors have fallen prey to it.
Momentum investing is basically the type of investing that people do when they follow trends.
Momentum investors buy stocks that have been very popular and appreciating rapidly and they hope that the trend will continue.
You've probably heard of the popular saying "buy low, sell high." Momentum investing has a similar slogan but it's:
Buy High and Sell Higher!
What Are Investment Trends?
In everyday life, you see tons of trends growing and fading before you. It may be the public's taste in music or clothes. Trends occur when the public finds something very popular and they "must have it."
From time to time, a certain stock or industry in the stock market will become very popular among investors and everyone will want to invest in that stock or industry.
For example, the construction sector has been soaring to new levels in the last year. Momentum investors would have seen this trend and would have tried to invest in it.
It's very true that trends can make investors a great deal of money but they also have many added risks that make momentum investing less appealing.
If you look back in time, you'll notice that trends don't last forever. When something becomes very popular, it usually takes off but ends in a sharp decline!
Stocks work the same way and if you get caught during this decline, you can lose a large amount of money.
Also, because momentum investors "buy high and try to sell higher," they usually have more room to lose money.
Momentum investors usually don't buy stocks near their lows. Instead, they buy near their highs and hope that they can appreciate even farther.
It's not always the case!
But stocks that are priced high and overvalued usually experience sharper declines than those that are undervalued.
You must keep your mind off short-term trends and invest for the long-term:
Trends come and go but real investors keep focused on their long-term goals without having to worry about what might happen the following day.